transaction id 60551802 case no. 12648-vcs in the court of
TRANSCRIPT
IN THE COURT OF CHANCERY OF THE STATE OF DELAWARE
EMSI ACQUISITION, INC.,
Plaintiff,
v.
CONTRARIAN FUNDS, LLC, PACIFIC LIFE INSURANCE COMPANY, PACIFIC LIFE & ANNUITY COMPANY, RELIASTAR LIFE INSURANCE COMPANY OF NEW YORK, MMD RESOURCES, LLP, MARK S. DAVIS (individually and in his capacity as guarantor of MMD RESOURCES, LLP), and ROBERT P. BROOK,
Defendants.
: : : : : : : : : : : : : : : : :
C.A. No. 12648-VCS
MEMORANDUM OPINION
Date Submitted: February 7, 2017 Date Decided: May 3, 2017
S. Mark Hurd, Esquire, Ryan D. Stottman, Esquire, and Lauren K. Neal, Esquire of Morris, Nichols, Arsht & Tunnell LLP, Wilmington, Delaware, and Stephen C. Hackney, Esquire and Timothy Knapp, Esquire of Kirkland & Ellis LLP, Chicago, Illinois, Attorneys for Plaintiff.
Rolin P. Bissell, Esquire and Paul J. Loughman, Esquire of Young Conaway Stargatt & Taylor LLP, Wilmington, Delaware and Marshall R. King, Esquire, Lauren M.L. Nagin, Esquire, Gabriel K. Gillett, Esquire of Gibson, Dunn & Crutcher LLP, New York, New York, Attorneys for Defendants.
SLIGHTS, Vice Chancellor
EFiled: May 03 2017 03:12PM EDT Transaction ID 60551802 Case No. 12648-VCS
1
Plaintiff, EMSI Acquisition, Inc. (tJaV^ci^[[u dg t<jnZgu', brings this action
against Defendants, Contrarian Funds, LLC, Pacific Life Insurance Company,
Pacific Life & Annuity Company, Reliastar Life Insurance Company, Reliastar Life
Insurance Company of New York, MMD Resources, LLP, Mark S. Davis, and
Robert P. <gdd` &id\Zi]Zg) t>Z[ZcYVcihu dg tMZaaZghu' to assert post-closing claims
[dg ^cYZbc^[^XVi^dc [daadl^c\ JaV^ci^[[wh VXfj^h^i^dc of EMSI Holding Company
&t?GMCu dg i]Z t=dbeVcnu' from the Defendants &i]Z t;Xfj^h^i^dcu'. The
Acquisition was memorialized in a Stock Purchase Agreement (the tMJ;u' which is
at the heart of this dispute. It is alleged that EMSI manipulated its financial
statements prior to the Acquisition in order to inflate its EBITDA and induce
Plaintiff to pay substantially more for the Company than it was worth. At issue is
whether Plaintiff may avoid contractual limits on recovery for indemnification
claims against the Sellers when the claims are based on fraudulent representations
in the SPA made by the Company. Also at issue is whether findings of an
independent auditor who attempted to resolve the dispute between the parties post-
Xadh^c\ bVn WZ tXdc[^gbZYu Wn i]Z =djgi jcYZg i]Z >ZaVlVgZ ;gW^igVi^dc ;Xi+
Plaintiff asserts two counts in a Verified Complaint (thZ t=dbeaV^ciu' V\V^chi
Defendants: Count I for indemnification and Count II for confirmation of the
ajY^idgwh VlVgY+ Defendants have moved to dismiss both counts for failure to state
a claim pursuant to Court of Chancery Rule 12(b)(6). For the reasons that follow,
2
I find that the SPA is ambiguous with respect to whether the Buyerwh indemnification
claims against the Sellers for allegedly fraudulent contractual representations of the
Company in the SPA are subject to contractual limitations on indemnification
claims. Extrinsic evidence is required to interpret the relevant provisions.
Accordingly, the motion to dismiss Count I is DENIED. The motion to dismiss
Count II, however, must be AL;HN?> Vh i]Z VjY^idgwh [^cY^c\h Yd cdi Xdchi^ijiZ
Vc VgW^igVi^dc VlVgY i]Vi ̂ h hjW_ZXi id tXdc[^gbVi^dcu jcYZg i]Z >ZaVlVgZ ;gW^igVi^dc
Act.
I. BACKGROUND
Cc Xdch^YZg^c\ >Z[ZcYVcihw bdi^dc id Y^hb^hh) C ]VkZ YgVlc i]Z [VXih [gdb i]Z
well-pled allegations in the Complaint, documents integral to the Complaint and
matters of which I may take judicial notice.1 At this stage of the proceedings, all
well-pled facts contained in the Complaint are assumed to be true.
A. The Parties and Relevant Non-Parties
Plaintiff, EMSI Acquisition, Inc., an affiliate of private equity firm Beecken
JZiin IwEZZ[Z % =dbeVcn) ̂ h the Buyer under the SPA. It is a Delaware corporation
with its corporate headquarters in Irving, Texas.
1 3P TG -TKOUQP /ZRNQTCVKQP 3PE' =]JQNFGT 6KVKI', 2014 WL 5449419, at *8 (Del. Ch. Oct. /1) /-.1' &t; _jY\Z bVn Xdch^YZg YdXjbZcih djih^YZ of the pleadings only when (1) i]Z YdXjbZci ^h ^ciZ\gVa id V eaV^ci^[[wh XaV^b VcY ^cXdgporated in the complaint or (2) i]Z YdXjbZci ^h cdi WZ^c\ gZa^ZY jedc id egdkZ i]Z igji] d[ ^ih XdciZcih+u' &^ciZgcVa quotation marks and citation omitted).
3
As noted, each of the Defendants named in the Complaint are alleged to be
Sellers under the SPA. Defendant, Contrarian Funds, LLC, is a Delaware LLC with
its principal place of business in Greenwich, Connecticut. Defendant, Pacific Life
Insurance Company, is a Nebraska insurance company with its principal place of
business in Newport Beach, California. Defendant, Pacific Life & Annuity
Company, is an Arizona insurance company with its principal place of business in
Newport Beach, California. Defendant, Reliastar Life Insurance Company, is a
Minnesota insurance corporation with its principal place of business in Minneapolis,
Minnesota. Defendant, Reliastar Life Insurance Company of New York, is a New
York insurance company with its principal place of business in Woodbury, New
York. And Defendant, MMD Resources, LLP, is an Arizona limited partnership
with its principal place of business in Scottsdale, Arizona.
Defendant, Mark S. Davis, is a former officer and shareholder of EMSI and a
guarantor of MMD Resources, FFJwh dWa^\Vi^dch jcYZg i]Z MJ;. He is named in
the Complaint both in his individual capacity and as guarantor. Defendant, Robert P.
Brook, ^h V [dgbZg d[[^XZg ^c ?GMCwh BZVai]XVgZ MZgk^XZh Y^k^h^dc VcY V [dgbZg
shareholder of EMSI.
Non-party, EMSI Holding Company, is a medical information services
XdbeVcn l]^X]) tTVUbdc\ di]Zg i]^c\h) TU XdaaZXih VcY XdYZh bZY^XVa gZXdgYh)
performs in-home health assessments, and supports clinical trials and drug-testing
4
heZX^bZc XdaaZXi^dch+u2 At the time of the Acquisition) ?GMCwh i]gZZ bV^c Wjh^cZhh
units were Healthcare Services, Insurance Services, and Investigative Services. The
Healthcare Services unit offers risk adjustment services to health plans and aids
employers in drug and alcohol testing and identity verification. The Insurance
Services unit aids life insurers with underwriting requirements and electronic
application processing services. The Investigative Services segment offers
investigative services to property, casualty and life insurance carriers.
B. EMSI Engages in a Sales Process
Defendants received their equity in EMSI through an out-of-court
restructuring in 2005, and soon afterwards began attempting to sell their interests in
the Company. This included formal sales processes in 2009 and 2012rrneither of
which resulted in a sale. In 2015, Defendants again decided to explore a sale of their
equity in EMSI, beginning the sales process with the release of a Confidential
Cc[dgbVi^dc GZbdgVcYjb &i]Z t=CGu' dc ;eg^a 0-) /-.2+ N]Z =CG egd_ZXiZY a
rosy outldd` [dg ?GMCwh [jijgZ) ZkZc i]dj\] this was out of line with historical
trends including a decline in profitability for the most recent fiscal year.
Plaintiff responded to the CIM in the summer of 2015 and the parties
negotiated the Acquisition from July through November 2015. Throughout these
2 Verified =dbea+ &t=dbea+u' q /.+
5
negotiations, the Defendants sent interim financial projections that forecast
th^\c^[^XVci cZVg-iZgb \gdli] ediZci^Va+u3 Plaintiff ultimately used the reported
EBITDA of $10.2 million for the trailing twelve months to price the Acquisition.
Based on this reported EBITDA, Plaintiff agreed to purchase EMSI on November 3,
2015 for $85 million.
C. The Relevant Provisions of the SPA
The SPA recognized the distinction between the Sellers and the Company.4
This distinction made sense given that, other than Davis and Brook, who were both
Sellers and members of Company management, the other Sellers were stockholders
who had received their equity in the Company through a restructuring. Based on the
allegations ^c i]Z =dbeaV^ci) i]ZgZ ^h cd ^cY^XVi^dc i]Vi i]Z tCchi^iji^dcVa MZaaZghu
(meaning those other than Davis and Brook) were at all involved in the management
of the Company.
The structure of the SPA is familiar to those who regularly encounter such
agreements. Article I outlined the transaction and set the purchase price: $85 million
with certain contemplated adjustments. Importantly, Article I also identified an
3 Compl. ¶ 28.
4 N]Z MJ; YZ[^cZh i]Z tMZaaZghu Vh =dcigVg^Vc @jcYh) FF=) JVX^[^X F^[Z CchjgVcXZ Company, Pacific Life & Annuity Company, Reliastar Life Insurance Company, Reliastar Life Insurance Company of New York, Mark S. Davis (both individually and on behalf of MMD Resources, LLP), and Robert P Brook. See Transmittal Aff. of Lauren K. Neal in Supp. o[ Ja+wh <g+ in Opp. td >Z[h+w Gdi+ id >^hb^hh ?m+ ; &tMJ;u' Preamble.
6
VY_jhibZci [dg Vc t?hXgdl ;bdjci)u $6)23/)2--) l]^X] ^h V [ZVijgZ d[ i]Z eVgi^Zhw
agreed-upon indemnification scheme.5 Article II outlined a post-closing purchase
price adjustment procedure that included, inter alia, a process whereby the parties
ldjaY t_d^cian Zc\V\Z TVU MZiiaZbZci ;jY^idgu id gZhdakZ Y^hejiZh gZ\VgY^c\ HZi
Working Capital and other identified purchase price adjustments.6 Any purchase
price adjustments determined to be due the Buyer were to be paid out of the Escrow
@jcYh VcY) t[dg i]Z Vkd^YVcXZ d[ YdjWi)u i]Z MJ; bVYZ XaZVg i]Vi tid i]Z ZmiZci i]Z
then-remaining Escrow Funds are insufficient to pay the full amount of any such
deficiency, no Seller (or other Escrow Payee) will have any liability to Buyer for
hjX] YZ[^X^ZcXn+u7
Article III set forth each of i]Z MZaaZgwh gZegZhZciVi^dch VcY lVggVci^Zh id i]Z
Buyer. They are noticeably more limited than those provided by the Company in
Article IV. Here again, this is not surprising given that the Institutional Sellers were
investors in, not managers of, the Company. Article III closes with the following
language:
5 SPA § 1.4(a).
6 SPA § 2.3.
7 SPA § 2.4(b).
7
NO ADDITIONAL REPRESENTATIONS OR WARRANTIES. EXCEPT AS OTHERWISE EXPRESSLY SET FORTH IN THE TRANSACTION DOCUMENTS, SUCH SELLERS EXPRESSLY DISCLAIMS ANY REPRESENTATIONS OR WARRANTIES OF ANY KIND OR NATURE, EXPRESS OR IMPLIED, AS TO THE CONDITION, VALUE, OR QUALITY OF THE COMMON SHARES OR THE BUSINESS OR THE ASSETS OR THE OPERATIONS OF THE EMSI ENTITIES OR ANY OTHER MATTER, AND SUCH SELLER SPECIFICALLY DISCLAIMS ANY REPRESENTATION OR WARRANTY OF MERCHANTABILITY, USAGE SUITABILITY, OR FITNESS FOR ANY PARTICULAR PURPOSE WITH RESPECT TO THE COMMON SHARES, THE BUSINESS, SUCH ASSETS, SUCH OPERATIONS, OR ANY PART THEREOF, OR AS TO THE WORKMANSHIP THEREOF, OR THE ABSENCE OF ANY DEFECTS THEREIN, WHETHER LATENT OR PATENT, IT BEING UNDERSTOOD THAT THE COMMON SHARES, THE BUSINESS, SUCH ASSETS AND SUCH OPERATIONS ARE ACQUIRED, REDEEMED, OR TERMINATED, AS APPLICABLE, v;M CM) QB?L? CMw IH NB? =FIMCHA >;N?) ;H> CH NB?CL PRESENT CONDITION.8
;gi^XaZ CP XdciV^ch i]Z =dbeVcnwh bdgZ ZmeVch^kZ hZi d[ gZegZhZciVi^dch VcY
warranties, several of which are at issue here. These included representations that
i]Z tjcVjY^iZY Xdchda^YViZY WVaVcXZ h]ZZih) hiViZbZci d[ deZgVi^dch) VcY XVh] [adlh
of the EMSI Entities for the six-month period ended September 30, 2015 . . . have
been prepared in accordance with GAAP applied on a consistent basis throughout
i]Z eZg^dYh XdkZgZY i]ZgZWnu89 i]Vi i]ZgZ ]VY WZZc cd tX]Vc\ZTU ^c Vcn h^\c^[^XVci
respect in Vcn Wjh^cZhh egVXi^XZu [gdb March 31, 2015 to the close of the
8 SPA § 3.9.
9 SPA §§ 4.17(a)(ii), 4.17(b).
8
Acquisition;10 i]Vi i]ZgZ ]VY WZZc cd tX]Vc\Z ^c i]Z bZi]dY d[ VXXdjci^c\ dr cash
bVcV\ZbZci egVXi^XZhu [gom March 31, 2015 to the close of the Acquisition;11 that
i]ZgZ ]VY WZZc cd tVXXZaZgViT^dc d[U i]Z XdaaZXi^dc d[ dg Y^hXdjciT^c\ d[U Vcn
VXXdjcih gZXZ^kVWaZu812 i]Vi i]ZgZ ]VY WZZc cd tVXi^dc dg [V^aTjgZU id iV`Z Vcn VXi^dc
that has had, or could reasonably be expected to have, the effect of accelerating to
pre-Closing periods sales to customers or others that would otherwise be expected
id dXXjg V[iZg i]Z =adh^c\u813 that there had been no agreements to change either the
Companywh Wjh^cZhh egVXi^XZh dg VXXdjci^c\ bZi]dYh [gdb i]Z i^bZ eZg^dY [gdm
March 31, 2015 and the close of the Acquisition;14 i]Vi i]ZgZ ]VY WZZc cd t=dbeVcn
GViZg^Va ;YkZghZ ?[[ZXiu h^cXZ GVgX] 0.) /-.2815 and that the Company Disclosure
Schedule incorporated within i]Z MJ; tXdciV^ch igjZ VcY XdbeaZiZ Xde^Zhu d[ i]Z
interim financial statements.16
10 SPA §§ 4.9(a)(i), 4.17(a)(i).
11 SPA § 4.9(a)(viii).
12 SPA § 4.9(a)(xi).
13 SPA § 4.9(a)(xiv).
14 SPA § 4.9(a)(xvii).
15 SPA § 4.9(c). t=dbeVcn GViZg^Va ;YkZghZ ?[[ZXiu bZVch) l^i] XZgiV^c YZh^\cViZY ZmXZei^dch) tVcn YZkZadebZci) X^gXjbhiVcXZ) X]Vc\Z) ZkZci dg XdcY^i^dc i]Vi) ^cY^k^YjVaan or in the aggregate, has had or is reasonably likely to have a materially adverse effect on the bus^cZhh d[ i]Z ?GMC ?ci^i^Zh) iV`Zc Vh V l]daZ + + +u MJ; ;gi^XaZ RC+
16 SPA § 4.17(a)(ii).
9
Article IV closes with a disclaimer nearly identical to the disclaimer in Article III:
EXCEPT AS OTHERWISE EXPRESSLY SET FORTH IN THE TRANSACTION DOCUMENTS, THE COMPANY EXPRESSLY DISCLAIMS ANY REPRESENTATIONS OR WARRANTIES OF ANY KIND OR NATURE, EXPRESS OR IMPLIED, AS TO THE CONDITION, VALUE, OR QUALITY OF THE COMMON SHARES OR THE BUSINESS OR THE ASSETS OR THE OPERATIONS OF THE EMSI ENTITIES OR ANY OTHER MATTER, AND THE COMPANY SPECIFICALLY DISCLAIMS ANY REPRESENTATION OR WARRANTY OF MERCHANTABILITY, USAGE SUITABILITY, OR FITNESS FOR ANY PARTICULAR PURPOSE WITH RESPECT TO THE COMMON SHARES, THE BUSINESS, SUCH ASSETS, SUCH OPERATIONS, OR ANY PART THEREOF, OR AS TO THE WORKMANSHIP THEREOF, OR THE ABSENCE OF ANY DEFECTS THEREIN, WHETHER LATENT OR PATENT, IT BEING UNDERSTOOD THAT THE COMMON SHARES, THE BUSINESS, SUCH ASSETS AND SUCH OPERATIONS ARE ACQUIRED, REDEEMED, OR N?LGCH;N?>) ;M ;JJFC=;<F?) v;M CM) QB?L? CMw IH NB? CLOSING DATE, AND IN THEIR PRESENT CONDITION, AND THAT BUYER SHALL RELY ON ITS OWN EXAMINATION AND INVESTIGATION THEREOF.17
As an accent to the disclaimers, in Article V, the Buyer represented that it was
only relying on the promises and representations contained in the SPA in a
straightforward non-reliance clause:
The Buyer acknowledges that the representations and warranties of the Company and Sellers expressly contained in this Agreement constitute the sole and exclusive representations and warranties of the Company and Sellers to Buyer in connection with the Transaction Documents and the transactions contemplated thereby. Buyer acknowledges that any financial projections or other forward-looking statements provided by the EMSI Entities are for illustrative purposes only and are not and will not be deemed to be relied upon by Buyer in executing, delivering the
17 SPA § 4.26.
10
Transaction Documents and performing the transactions contemplated thereby. Notwithstanding the foregoing, nothing in this Section 5.7 shall limit the right of Buyer to rely on the representations and warranties, covenants and agreements set forth in this Agreement or in any Schedule or Exhibit (or in any certificate delivered with respect i]ZgZid ]ZgZjcYZg' dg <jnZgwh g^\]i id ^cYZbc^[^cation hereunder.18
The parties also negotiated a comprehensive indemnification regime within
Article X of the SPA. The MZaaZgwh ^cYZbc^[^XVi^dc dWa^\Vi^dch VgZ hZi [dgi] ^c
Section 10.2:
Subject to the other provisions of this Article X, (including, without limitation, Section 10.4), each Seller shall . . . indemnify and hold ]VgbaZhh + + + i]Z tBuyer Indemnified Partiesu Td[ l]^X] JaV^ci^[[ is a member] . . . from any and all Losses which any of the Buyer Indemnified Parties may sustain arising out of: (a) any breach of any representation or warranty of such Seller or the Company contained in this Agreement; (b) any breach of any covenant or agreement of such Seller that is contained in this Agreement . . .19
The a^b^ih jedc MZaaZgwh ^cYZbc^[^XVi^dc dWa^\Vi^dch VgZ provided in
Section 10.4:
Notwithstanding anything to the contrary in this Agreement (including, without limitation, Section 10.2) . . . : (b) The Buyer Indemnified Parties shall not be entitled to indemnification under Section 10.2(a) for any and all Losses unless and until the aggregate amount of all of the Losses . . . for which the Buyer Indemnified Parties would otherwise be entitled to indemnification pursuant to Section 10.2(a) exceed $450,000 &i]Z tBasket Amountu') ^c l]^X] ZkZci) hjW_ZXi id i]Z iZgbh d[ i]^h Article X and the Escrow Agreement, the Buyer Indemnified Parties will be entitled to be indemnified in accordance with Section 10.2(a)
18 SPA § 5.7.
19 SPA § 10.2.
11
for such Losses . . . in excess of the Basket Amount to the extent of, and exclusively from, any then-remaining Escrow Funds.20
Section 10.4(d) further limits MZaaZgwh indemnification liability to the amount
of the set-aside Escrow Funds by providing that, t[n]otwithstanding anything to the
XdcigVgn ^c i]^h ;\gZZbZciu:
The Buyer Indemnified Parties shall only be entitled to indemnification (i) with respect to Losses in respect of the representations and warranties (other than the Excluded Representations and the Specific Indemnity Items) to the extent of, and exclusively from, any then-remaining Escrow Funds . . .21
Section 10.10(a) makes clear that indemnification is the exclusive remedy for
V MZaaZgwh WgZVX] d[ V gZegZhZciVi^dn, warranty or covenant:
From and after Closing (except . . . in the case of claims for fraud or willful or intentional misrepresentation), the sole and exclusive remedy of the Seller Indemnified Parties and the Buyer Indemnified Parties for any breach or inaccuracy, or alleged breach or inaccuracy, of any representation, warranty or covenant under, or for any other claims arising in connection with, any of the Transaction Documents, other than specific performance, shall be indemnification in accordance with this Article X, subject to the limitations set forth herein . . .22
Section 10.10(b) of the SPA then appears to carve out from this limitation
tanyu XaV^b tWVhZY jedc [gVjYu:
20 SPA § 10.4(b).
21 SPA § 10.4(d).
22 SPA § 10.10(a).
12
Notwithstanding anything in this Agreement to the contrary (including . . . any limitations on remedies or recoveries . . .) nothing in this Agreement (or elsewhere) shall limit or restrict (i) any Indemnified JVginwh g^\]ih dg VW^a^in id bV^ciV^c dg gZXdkZg Vcn Vbdjcih ^c connection with any action or claim based upon fraud in connection with the transactions contemplated hereby . . .23
D. Plaintiff Discovers FraudZQJSY ;NXWJUWJXJSYFYNTSX NS 3;@7_X 4NSFSHNFQ Statements and Related SPA Reps and Warranties After Closing
?GMCwh [^cVcX^Va eZg[dgbVcce dramatically declined after the close of the
Acquisition, in contrast to the bright future for the Company the Defendants had
forecast throughout the sales process.24 This prompted Plaintiff to conduct a forensic
^ckZhi^\Vi^dc l]^X] gZkZVaZY tV =dbeVcn i]Vi lVh gZVYn io implode because of
months of financial manipulation, acceleration of revenue, and recognition of sham
gZkZcjZ VcY ZVgc^c\h+u25 Plaintiff alleges specifically that the financial fraud was
implemented i]gdj\] bVc^ejaVi^dc d[ i]Z =dbeVcnwh ldg` ^c egd\gZhh &tQCJu)
model by inflating volume and prices, accelerating revenue recognition for projects
the Company was not yet working on, overstating assumptions about what
percentage of contracts would be completed and falsifying its progress on ongoing
projects.
23 SPA § 10.10(b).
24 Compl. ¶¶ 2r11, 161r73.
25 Compl. ¶ 175.
13
As alleged in the Complaint, the =dbeVcnwh ZbeadnZZh `cdl^c\an Zc\V\ZY
in the scheme to manipulate the WIP in the ramp up to sell the Company. In June
2015, the Controller, the Executive Vice President of the Healthcare Division and
the Division Controller for the Healthcare Division emailed EMSI employees about
millions of dollars in WIP revenue that needed to be written off the financial
statements. As instructed, EMSI employees thereafter created a new version of the
=dbeVcnwh financials that wrote off substantial WIP. During the diligence process,
however, EMSI accounting and operations employees reinstated this revenue on the
books without explanation or disclosure to the Buyer+ ?GMCwh >^k^h^dc =dcigdaaZg
for the Healthcare Division was repeatedly told by the Executive Vice President of
the Healthcare Division manually to override parts of the WIP model so that revenue
recognition would be accelerated. When she expressed her unease with these
practices, the Division Controller was told that this direction was coming from
tbVcV\ZbZci+u26 EMSI employees also created a fake data file in June 2015 to
recognize revenue on a project that had not yet been approved by the client.
This was part of a greater pattern where, from June 2015 until the closing,
EMSI employees would routinely recognize revenue on projects that the employees
knew were not approved by clients. ?GMCwh ?mZXji^kZ P^XZ JgZh^YZci d[ i]Z
26 Compl. ¶ 86.
14
Healthcare Division and the Division Controller also systematically increased
completion percentages in the WIP model in August 2015 to inflate revenue and
accounts receivable. When the Division Controller again expressed her view that
i]Z X]Vc\Zh lZgZ tVgW^igVgn VcY ^cYZ[Zch^WaZ)u i]Z =@I gZhednded that the changes
were directed by management and would remain intact.27 The Executive Vice
President of the Healthcare Division was also alerted that the same project was
^cXajYZY il^XZ ^c ?GMCwh [^cVcX^Va gZXdgYh ^c IXidWZg /-.2) leading to the
recognition of over $500,000 in extra revenue, and yet he chose to do nothing to fix
the error.
E. The Parties Engage an Independent Auditor to Make a Net Working Capital Adjustment
After discovering the fraud and realizing that it had received substantially less
than the $41 million in working capital it had bargained for, Plaintiff promptly
initiated the so-XVaaZY tnet working capital adjustment processu that was laid out in
Article II of i]Z MJ;+ Cc i]Vi egdXZhh) >Z[ZcYVcih XdcXZYZY i]Vi ?GMCwh cZi ldg`^c\
capital was overstated by over $4 million in the interim financial statements and
returned those funds to Plaintiff, but disputed JaV^ci^[[wh XdciZci^dc i]Vi another $5.8
million in accounts receivable ^YZci^[^ZY ^c i]Z =dbeVcnwh financial statements
could not be justified under GAAP. To resolve that dispute, as mandated by the
27 Compl. ¶ 115.
15
SPA, Plaintiff initiated a formal dispute resolution process with an auditor (the
tMZiiaZbZci ;jY^idgu' to determine the appropriate GAAP accounting. The
Settlement Auditor agreed with Plaintif[ VcY XdcXajYZY i]Vi ?GMCwh [^cVcX^Va
statements overstated its accounts receivable by the $5.8 million claimed by Plaintiff
in addition to the $4 million net capital overage that Defendants had conceded.
The aggregate purchase price adjustments made pursuant to the SPA totaled
$9,894,520 (the voluntary adjustment of $4,085,379, plus the Settlement Auditor
determination of $5,809,150), which exceeds the $9,562,500 placed in escrow. The
Escrow Funds are gone.28 Consequently, it is not disputed that if JaV^ci^[[wh XaV^bs
in this action are subject to the contractual limitations set forth in the SPA, which
would cap JaV^ci^[[wh recovery at the available Escrow Funds, then, as a practical
matter, the claim is not viable.
F. Procedural History
Plaintiff initiated this action to recover the shortfall in its recovery of the
Settlement ;jY^idgwh net working capital determination by having this Court
tXdc[^gbu i]Z [^cY^c\h Vh Vc VlVgY jcYZg i]Z >ZaVlVgZ ;gW^igVi^dc ;Xi and also to
tgZXdkZg i]Z ^c[aViZY eg^XZ ^i eV^Y Vh V gZhjai d[ i]Z =dbeVcnwh [gVjYu i]gdj\] i]Z
28 As the Joint Written Instruction makes clear, the only remaining funds held by the escrow V\Zci V[iZg hjX] Y^hWjghZbZci ldjaY tXdchi^ijiZ i]Z MVaZh NVm ?hXgdl ;bdjciu &Ex. 4), which is a separate pool of money set aside solely for potential sales tax liabilities that is not available to satisfy any purchase price adjustment or indemnification obligation (see SPA § 1.4(a) & Art. XI).
16
indemnification provisions in the SPA.29 Defendants promptly moved to dismiss the
=dbeaV^ci Vg\j^c\ i]Vi JaV^ci^[[wh gZXdkZgn jcYZg i]Z MJA was limited to the now-
depleted Escrow Funds and that the SettlZbZci ;jY^idgwh [^cY^c\h Y^Y cdi Xdchi^ijiZ
a binding award that can be converted to a confirmed judgment under Delaware law.
II. ANALYSIS
A. Motion to Dismiss Standard
In considering this motion to dismiss for failure to state a claim under
Rule 12(b)(6), the standard is well settled:
(i) all well-pleaded factual allegations are accepted as true; (ii) even kV\jZ VaaZ\Vi^dch VgZ vlZaa-eaZVYZYw ^[ i]Zn \^kZ i]Z deedh^c\ eVgin notice of the claim; (iii) the Court must draw all reasonable inferences in favor of the non-moving party; and (iv) dismissal is inappropriate jcaZhh i]Z veaV^ci^[[ ldjaY cdi WZ Zci^iaZY id gZXdkZg jcYZg Vcn gZVhdcVWan XdcXZ^kVWaZ hZi d[ X^gXjbhiVcXZh hjhXZei^WaZ d[ egdd[+w30
Questions involving contract interpretation can be answered on a motion to
Y^hb^hh tTlU]Zc i]Z aVc\jV\Z d[ V XdcigVXi ^h eaV^c VcY jcVbW^\jdjh+u31 But
Y^hb^hhVa d[ V XdcigVXi Y^hejiZ jcYZg LjaZ ./&W'&3' ̂ h egdeZg tdcan ̂ [ i]Z YZ[ZcYVcihw
^ciZgegZiVi^dc ^h i]Z dcan gZVhdcVWaZ XdchigjXi^dc Vh V bViiZg d[ aVl+u32 If the
29 Ja+wh <g+ ^c Iee+ id >Z[h+w Gdi+ id >^hb^hh &t;chlZg^c\ <g+u' 19.
30 Savor, Inc. v. FMR Corp., 812 A.2d 894, 896r97 (Del. 2002) (citations omitted).
31 Capital Corp. v. GC Sun Hldgs., L.P., 910 A.2d 1020, 1030 (Del. Ch. 2006).
32 VLIW Tech., LLC v. Hewlett-Packard Co., 840 A.2d 606, 615 (Del. 2003).
17
Plaintiff has offered a reasonable construction of the contract, and that construction
supports the claims asserted in the complaint, then the Court must deny the motion
id Y^hb^hh ZkZc ^[ i]Z YZ[ZcYVciwh XdchigjXi^dc ^h Vahd reasonable.33
B. Plaintiff has Adequately Pled an Indemnification Claim Based on Fraud that Is Not Capped by the Escrow Funds
Defendants d[[Zg ild \gdjcYh jedc l]^X] i]Z =djgi bjhi Y^hb^hh JaV^ci^[[wh
indemnification claim. First, they argue that the claim is subject to the limitation
within the SPA that would cap any recovery at the amount of available Escrow
Funds, which both sides acknowledge are now depleted. According to Defendants,
JaV^ci^[[wh XdcigVgn XdchigjXi^dc d[ i]Z MJ;) l]^X] ldjaY Vaadl Vny claim tWVhed
upon fraudu to proceed against the Sellers without regard to the contractual limits on
recovery, cannot be squared with the clear and unambiguous language of the SPA.
Second, Defendants maintain i]Vi ZkZc ^[ JaV^ci^[[wh ^ciZgegZiVi^dc d[ i]Z MJ; ^h
reasonable, the Complaint fails to plead fraud with particularity as required by Court
of Chancery Rule 9(b). For reasons explained below, at this pleadings stage, neither
ground is persuasive.
33 See Vanderbilt Income and Growth Assocs., L.L.C. v. Arvida/JMB Managers, Inc., 691 ;+/Y 3-6) 3.0 &>Za+ .663' &tIc V bdi^dc id Y^hb^hh [dg [V^ajgZ id hiViZ V XaV^b) V ig^Va Xdjgi cannot choose between two differing reasonable interpretations of ambiguous YdXjbZcih+u'+
18
1. Abry Partners V, L.P. v. F&W Acquisition LLC and its Implications Here
Before I turn to the specifics of this case, it is appropriate to dilate for a
moment on th^h Xdjgiwh seminal opinion in Abry Partners V, L.P. v. F&W Acquisition
LLC, which Defendants claim served as a road map for the provisions they bargained
for in the SPA.34 In Abry, a private equity firm purchased the shares of a publishing
company from another private equity seller and thereafter sought rescission of the
stock purchase agreement due to alleged fraud on the part of the company and the
seller.35 This scenario served as a platform for the court to consider the state of the
law in Delaware with respect to freedom of contract, risk allocation in transactions
between sophisticated parties and the consequences of fraud in the sales process.
Defendants are correct that these issues are front and center in this case.
The contract at issue in Abry contained a broad non-reliance clause. Having
V\gZZY id i]^h egdk^h^dc) i]Z Xdjgi lVh cdi idaZgVci d[ i]Z WjnZgwh XaV^b i]Vi i]Z hZaaer
had made false, extra-contractual promises upon which the buyer relied when it
agreed to close the transaction.36 Under such circumstances, to allow the buyer to
34 891 A.2d 1032 (Del. Ch. 2006).
35 Id. at 1035.
36 Id. Vi .-26 &ZmeaV^c^c\ i]Vi tTiU]Z ^ciZ\gVi^dc XaVjhZ bjhi XdciV^c vaVc\jV\Z i]Vi + + + XVc be said to add up to a clear anti-reliance clause by which the plaintiff has contractually promised that it did not rely upon statements outside the XdcigVXiwh [djg XdgcZgh ̂ c YZX^Y^c\ to sign the contractwu'+
19
pursue a fraud claim based on extra-contractual representations would be tantamount
to conddc^c\ i]Z WjnZgwh [gVjY ^c gZegZhZci^c\ ^c i]Z XdcigVXi i]Vi ^i ]VY cdi gZa^ZY
upon any representations beyond those that appeared in the agreement.37
In addition to alleging extra-contractual fraud, the buyer in Abry also alleged
that the seller and the company intentionally misrepresented facts in the contract.
This contractual fraud, the buyer alleged, allowed it avoid the limitations in the
agreement that precluded the buyer from pursuing rescission for breach of
representations and warranties and capped damages for indemnification at $20
million, the amount placed in escrow to cover any post-closing claims of the buyer.38
N]Z hZaaZg Y^hV\gZZY VcY Vg\jZY i]Vi i]Z eVgi^Zh ]VY V\gZZY i]Vi i]Z hZaaZgwh g^h` [dg
indemnification would be capped in all instances at the amount the seller had
bargained forrr$20 million.39
37 Id. See also id. Vi .-02 &tLZXd\c^o^c\ i]Vi i]Z XVhZ aVl d[ i]^h Xdjgi \^kZh Z[[ZXi id cdc-reliance provisions that disclaim reliance on extra-contractual representations, the Buyer has premised its rescission claim solely on the falsity of representations and warranties XdciV^cZY l^i]^c i]Z MidX` JjgX]VhZ ;\gZZbZci ̂ ihZa[+u'8 id. Vi .-25 &tN]Z Zc[dgXZbZci d[ non-reliance clauses recognizes that parties with free will should say no rather than lie in a contract.u'+
38 Id. at 1059.
39 Id. Vi .-2/ &tCc hjbbVgn, though, the [SZaaZgwhU Vg\jbZci egdXZZYh Vh [daadlh+ N]Z Stock Purchase Agreement is a carefully negotiated document that allocates economic risk. It was entered into by sophisticated parties in the private equity markets. In that Agreement, the parties carefully set forth which representations and warranties were made by the Company and which were made by the Seller. The Buyer also explicitly promised that the only information it relied upon in entering into the Agreement was that represented and warranted in the Agreement itself, thus contractually pledging that it had not relied on
20
After balancing >ZaVlVgZwh higdc\ XdcigVXiVg^Vc egZ[ZgZcXZh V\V^chi i]Z lZaa-
settled public policy of this State that abhors fraud, the court concluded that, tid i]Z
ZmiZci i]Vi i]Z MidX` JjgX]VhZ ;\gZZbZci ejgedgih id a^b^i i]Z MZaaZgwh ZmedhjgZ [dg
its own conscious participation of lies to the Buyer,u40 the provision was void as a
matter of law. Accordingly, the court declined to dismiss the buyerwh XaV^b df
contractual fraud against the seller. But the court made clear that the claim survived
because the buyer had pled facts that allowed a reasonable inference either that the
seller knew that the representations and warranties made by the company were false
or that the seller itself had made fraudulent representations and warranties.41 In this
regard, the court emphasized that the buyer could avoid the bargained-for limits on
its remedies only if it could prove that i]Z hZaaZg VXiZY l^i] Vc t^aa^X^i hiViZ d[ b^cYu;42
otherwise, if the buyerwh egdd[ gZkZVaZY dnly that the company had misrepresented
extra-contractual representations. In addition, the Buyer agreed to the exclusive Remedy Provision stating that the only remedy that it had against the Seller for contractual b^hgZegZhZciVi^dch lVh a^b^iZY id V + + + CcYZbc^in =aV^b+ ;cY) ^c i]Vi ZkZci) i]Z MZaaZgwh liability is capped at the extent of the Indemnity Fund for $20 million. Furthermore, the Agreement explicitly indicated that the Exclusive Remedy Provision and limitation on a^VW^a^in XdciV^cZY ^c i]Z XdcigVXi lZgZ WVg\V^cZY [dg VcY gZ[aZXiZY ^c i]Z hVaZ eg^XZ+u'+
40 Id. at 1064. See also id. Vi .-26 &cdi^c\ i]Z thigdc\ igVY^i^dc ̂ c ;bZg^XVc aVl that holds that contracts may not insulate a party from damages or rescission resulting from the eVginwh [gVjYjaZci XdcYjXiu'+
41 Id. at 1064.
42 Id.
21
[VXih l^i]dji i]Z hZaaZgwh `cdlaZY\Z d[ i]Z [Vah^in) i]Zc i]Z WjnZg ldjaY be limited
to the bargained-for indemnity claim and its associated limitations.43
2. The Parties Have Offered Reasonable Competing Interpretations of the SPA
Abry provides a solid analytical framework within which to analyze the
arguments of buyers and sellers who seek to exploit the risk allocation provisions of
their transactional agreements, bargained-for on a clear day but deployed in the
midst of post-closing controversy. As our courts have recognized, t[d]eal-related
inYZbc^[^XVi^dc egdk^h^dch VYYgZhh vedhi-Xadh^c\ g^h` VaadXVi^dc+wu44 They serve the
laudable ejgedhZ d[ tbV`T^c\U i]Z XdcigVXijVa higjXijgZ [ZVh^WaZ dg bdgZ ViigVXi^kZ
id i]Z eVgi^X^eVcih+u45 Parties can shift risks of loss in their indemnification schemes
as is appropriate and necessary to get the deal done, and can disclaim certain claims
and remedies as well.46 Bji t>ZaVlVgZwh higdc\ ejWa^X eda^Xn V\V^chi ^ciZci^dcVa
43 Id. &hiVi^c\ i]Vi i]Z WjnZg t]Vh cd bdgVa _jhi^[^XVi^dc [dg ZhXVe^c\ ^ih dlc kdajciVg^an-accepted limits on its remedies against the Seller absent proof that the Seller itself acted in V XdchX^djhan ^begdeZg bVccZgu'+
44 White v. Curo Texas Hldgs., LLC, 2016 WL 6091692, at *11 (Del. Ch. Sept. 9, 2016).
45 .GNRJK /CUVGT ;]TU 6VF' X' =RGEVCEWNCT ;]TU% 3PE', 1993 WL 328079, at *2 (Del. Ch. Aug. 6, 1993).
46 Abry, 891 A.2d at 1058.
22
[gVjYu l^aa cdi eZgb^i a party to a contract to disclaim or eliminate a claim that it
maYZ tV `cdl^c\an [VahZ XdcigVXijVa gZegZhZciVi^dc+u47
The SPA contains a non-reliance clause in Section 5.7, where Plaintiff
specifically disclaimed any reliance on extra-contractual representations. As Abry
reiterates, these types of non-reliance clauses will be upheld where the clause
XdciV^ch taVc\jV\Z i]Vi + + + XVc WZ hV^Y id VYY je id V XaZVg Vci^-reliance clause by
which the plaintiff has contractually promised that it did not rely upon statements
djih^YZ i]Z XdcigVXiwh [djg XdgcZgh ^c YZX^Y^c\ id h^\c i]Z XdcigVXi+u48 Section 5.7
arguably fits that bill. Plaintiff is also bound Wn i]Z MJ;wh hZeVgVi^dc d[ i]Z
representations and warranties of the Seller from those of the Company and by the
language at the end of Article III which states clearly that the representations and
warranties in that article are the only ones being made by the Seller. Given this
scheme, it is not surprising that Plaintiff has not sought to stake its fraud claim
47 Airborne Health, Inc. v. Squid Soap, LP, 984 A.2d 126, 136r37 (Del. Ch. 2009) (citing +DT[ ;]TU, 891 A.2d at 1061r64).
48 Kronenberg v. Katz, 872 A.2d 569, 593 (Del. Ch. 2004).
23
against the Sellers on extra-contractual ground.49 Under Abry and its progeny,50
therefore, absent a contractual portal, the Plaintiff (Buyer) cannot reach the
Defendants (Sellers) on an indemnification claim beyond the bargained-for limits
(the Escrow Funds) unless Plaintiff can demonstrate that Defendants acted with an
t^aa^X^i hiViZ d[ b^cYu dg t`cZl i]Vi i]Z =dbeVcnwh gZegZhZciVi^dch VcY lVggVci^Zh
lZgZ [VahZ+u51
Defendants maintain that they took pains when they negotiated the SPA to
]dcdg >ZaVlVgZwh ejWa^X eda^Xn VcY i]Z ]daY^c\ ^c Abry Wn egZhZgk^c\ i]Z eVgi^Zhw
r^\]ih id Wg^c\ tV cdc-XdcigVXijVa XaV^b WVhZY dc [gVjYu djih^YZ d[ i]Z thig^XijgZh
i]Vi Veean id XdcigVXijVa ^cYZbc^[^XVi^dc XaV^bh+u52 Specifically, consistent with
Abry, the SPA, at Section 10.10(a), egZhZgkZh XaV^bh [dg t[gVjY dg l^aa[ja dg
49 See Abry ;]TU) 56. ;+/Y Vi .-24 &hiVi^c\ i]Vi tV eVgin XVccdi egdb^hZ) ^c V XaZVg integration clause of a negotiated agreement, that it will not rely on promises and gZegZhZciVi^dch djih^YZ d[ i]Z V\gZZbZci VcY i]Zc h]^g` ^ih dlc WVg\V^c ^c [Vkdg d[ V vWji we did rZan dc i]dhZ di]Zg gZegZhZciVi^dchw [gVjYjaZci ^cYjXZbZci XaV^bu'+ C cdiZ i]Vi Article X may be read to allow extra-contractual claims for fraud notwithstanding the non-reliance clause. Indeed, as discussed below, that is how Defendants interpret the pari^Zhw bargained-for indemnification scheme. Plaintiff, of course, has not pursued an extra-contractual fraud claim here and one can only surmise that it made that strategic decision, at least in part, based upon its appreciation that the non-reliance clause would likely complicate the prosecution of that claim.
50 =GG G'I' 1TGCV 2KNN /SWKV[ ;]rs IV, LP v. SIG Growth Equity Fund I, LLP, 2014 WL 6703980, at *27 (Del. Ch. Nov. 26, 2014).
51 Abry, 891 A.2d at 1064.
52 Reply Br. of Defs. in Supp. Of their Mot. To >^hb^hh i]Z PZg^[^ZY =dbea+ tLZean <g+u at 2r3.
24
^ciZci^dcVa b^hgZegZhZciVi^dcu by the Sellers within and subject to the
indemnification framework. Section 10.10(b) then makes clear that extra-
XdcigVXijVa XaV^bh tWVhZY jedc [gVjYu against the Sellers are not subject to the
bargained-for limits on remedies for contractual indemnification.
According to Defendants, this scheme, consistent with Delaware law,
tpgdk^YZh [dg vild eVi]h id gZXdkZgnw [dg V ejgX]VhZg VaaZ\^c\ b^hgZegZhZciVi^dch ^c
XdccZXi^dc l^i] V hidX` ejgX]VhZ V\gZZbZci7 v&.' hj^c\ XdcigVXijVlly and going
through the indemnification provisions or (2) suing for fraud.wu53 This is because,
^c >Z[ZcYVcihw gZVY^c\) Abry bV`Zh XaZVg i]Vi tT^U[ i]Z =dbeVcnwh bVcV\Zgh
intentionally misrepresented facts to the Buyer without knowledge of falsity by the
Seller, then the Buyer . . . must proceed with an Indemnity Claim subject to the
3PFGOPKV[ 0WPF]U NKCDKNKV[ ECR+u54 Thus, Defendants maintain that JaV^ci^[[wh only
options for recovery are either to (1) seek indemnification for breaches of
representations and warranties from the now-dissipated Escrow Funds, or (2) bring
a claim for fraud against Defendants based on the MZaaZghw dlc fraudulent actions
hjW_ZXi) d[ XdjghZ) id i]^h =djgiwh ]Z^\]iZcZY eleading standards for fraud.
53 Reply Br. at 1 (citing Anvil Hldg. Corp. v. Iron Acq. Co., Inc., 2013 WL 2249655, at *9 (Del. Ch. May 17, 2013)).
54 +DT[ ;]rs, 891 A.2d at 1064 (emphasis added).
25
Plaintiff disagrees and maintains that the parties took a step beyond Abry in
Section 10.10(b), in order id tYZVaTU l^i] i]Z egZX^hZ h^ijVi^dc ^YZci^[^ZY ]ZgZ,u Wn
Vaadl^c\ i]Z <jnZg) l^i]dji a^b^iVi^dc dg gZhig^Xi^dc) tid recover any amounts in
XdccZXi^dc l^i] Vcn VXi^dc dg XaV^b vWVhZY jedc [gVjYw ^c XdccZXi^dc l^i] i]Z
XdciZbeaViZY igVchVXi^dc+u55 Plaintiff contends that, in this respect, unlike in Abry,
the SPA deliberately tallocated to Sellers the risk that the Company was knowingly
b^hgZegZhZci^c\ ̂ ihZa[ l]Zc ̂ i ZciZgZY ̂ cid i]Z MJ;+u56 And since its indemnification
claim is tWVhZY jedcu i]Z VaaZ\ZYan [gVjYjaZci b^hgZegZhZciVi^dch ^c i]Z
representations and warranties by the Company, as opposed to merely innocent
breaches of the SPA, Plaintiff argues that the claim is not subject to the limitations
on recovery imposed by Section 10.4(b). This is so, Plaintiff maintains, even if it
has not pled and cannot prove that the Sellers acted with scienter in connection with
their own representations and warranties or knew that the =dbeVcnwh
representations and warranties were false when made.
Contract construction, in this instance, is complicated by two competing
tcdil^i]hiVcY^c\ XaVjhZhusone in Section 10.10(b) providing that
tTcUotwithstanding anything in this Agreement to the contrary (including . . . any
limitations on remedies or recoveries . . .) nothing in this Agreement (or elsewhere)
55 Answering Br. at 2r3; SPA § 10.10(b).
56 Answering Br. at 3.
26
shall limit or restrict . . . Vcn CcYZbc^[^ZY JVginwh g^\]ih dg VW^a^in id bV^ciV^c dg
recover any amounts in connection with any action or claim based upon fraud in
connection with the transactions contemplated herebyu8 and the other in
Section 10.4(d) egdk^Y^c\ i]Vi tTcUotwithstanding anything to the contrary in this
Agreement (including, without limitation, Section 10.2) . . . : (b) The Buyer
Indemnified Parties shall not be entitled to indemnification under Section 10.2(a) for
any and all Losses . . . in excess of . . . and exclusively from, any then-remaining
Escrow Funds+u57 Generally, tTiU]Z jhZ d[ hjX] V vcdil^i]hiVcY^c\w XaVjhZ XaZVgan
h^\cVah i]Z YgV[iZgwh ^ciZci^dc i]Vi i]Z egdk^h^dch d[ i]Z vcdil^i]hiVcY^c\w hZXi^dc
dkZgg^YZ Xdc[a^Xi^c\ egdk^h^dch d[ Vcn di]Zg hZXi^dc+u58 This tenant of construction
is less useful when the contract contains two apparently conflicting
tcdil^i]hiVcY^c\u XaVjhZh, both of which, at first glance, appear to toverrideu the
other.59
57 SPA §§ 10.10(b) (emphasis added); 10.4(d) (emphasis added).
58 In re Estate of Crist, 863 A.2d 255, 258 (Del. Ch. 2004), CHH]F, 876 A.2d 602 (Del. 2005). See also Medicis Pharm. Corp. v. Anacor Pharm., Inc., 2013 WL 4509652, at *8 n.46 (Del. Ch. Aug. 12, 2013) (citing Cisneros v. Alpine Ridge Gp.) 2-5 O+M+ .-) .5 &.660' &tTNU]Z jhZ d[ hjX] V vcdil^i]hiVcY^c\w XaVjhZ XaZVgan h^\cVah i]Z YgV[iZgh ^ciZci^dc i]Vi i]Z egdk^h^dch d[ i]Z vcdil^i]hiVcY^c\w hZXi^dc dkZgg^YZ Xdc[a^Xi^c\ egdkisions of any other hZXi^dc+u''+
59 Cf. Osborn ex rel. Osborn v. Kemp) 66. ;+/Y ..20) ..3- &>Za+ /-.-' &t;c jcgZVhdcVWaZ interpretation produces an absurd result or one that no reasonable person would have VXXZeiZY l]Zc ZciZg^c\ i]Z XdcigVXi+u'+
27
Defendants reconcile these apparently contradictory provisions by arguing
that Section 10.10(b) only removes the limitations on liability for extra-contractual
fraud claims.60 Under this construction, the limits imposed by Sections 10.2(a) and
10.4(d) still apply to i]Z JaV^ci^[[wh XaV^b [dg ^cYZbc^[^XVi^dc against the Sellers
based on fraud by the Company to the extent the claim arises from
misrepresentations within the contract.61 Plaintiff responds that >Z[ZcYVcihw
proffered XdchigjXi^dc gZcYZgh i]Z tcdil^i]hiVcY^c\u XaVjhZ ^c MZXi^dc .-+.-&W'
meaningless. According to JaV^ci^[[) i]Z theZX^[^X vcdil^i]hiVcY^c\w XaVjhZ ^c
MZXi^dc .-+.-&W') l]^X] ZmegZhhan Y^hXaV^bh vVaa a^b^iVi^dch dc gZbZY^Zh dg
gZXdkZg^Zh)w bjhi egZkV^a dkZg i]Z \ZcZgVa vcdil^i]hiVcY^c\w XaVjhZ ^c Section 10.4,
60 This construction of 10.10(b) would also take the indemnification scheme beyond Abry, which held that the non-reliance clause in the stock purchase agreement at issue precluded the buyer from suing on extra-contractual representations, even if fraudulent. Abry, 891 A.2d at 1059.
61 Defendants also contend that JaV^ci^[[wh h^c\jaVg [dXjh dc MZXi^dc .-+.-&W' \jih i]Z eVgi^Zhw XVgZ[jaan cZ\di^ViZY ^cYZbc^[^XVi^dc gZ\^bZ VcY gZcYZgh bZVc^c\aZhh hZkZgVa egdk^h^dch d[ i]Z MJ;) ̂ cXajY^c\ MZXi^dc .-+1&Y'wh gZhig^Xi^dc d[ ̂ ndemnification recoveries id ti]Zc-gZbV^c^c\ ZhXgdl [jcYhu VcY MZXi^dc .-+.-&V'wh gZXd\c^i^dc i]Vi ZmigV-contractual fraud fits within the indemnification regime. ;XXdgY^c\ id >Z[ZcYVcih) JaV^ci^[[wh construction of the SPA would violate the settled canon of contract construction that gZfj^gZh i]Z Xdjgi id ^ciZgegZi XdcigVXih hd Vh id cdi gZcYZg V egdk^h^dc tbZVc^c\aZhh dg ^aajhdgn+u Coughlan v. NXP B.V., 2011 WL 5299491, at *8 (Del. Ch. Nov. 4, 2011).
28
which is included in the preamble clause, and not specifically tied to the
^cYZbc^[^XVi^dc a^b^ih ^c MZXi^dc .-+1&W'+u62
At this juncture, I find that it is at least reasonable to view the competing
tcdil^i]hiVcY^c\u clauses as conflicting and to interpret the tnotwithstandingu
clause in Section 10.10(b) as trumping the tnotwithstandingu clause in
Section 10.4.63 Whether the parties intended the tcdil^i]hiVcY^c\u XaVjhe in
Section 10.10(b) to go beyond Abry by removing limits on i]Z MZaaZgwh liability for
tVcnu XaV^b tWVhZY jedc [gVjY,u including claims that the Company alone
committed fraud in its contractual representations and warranties, cannot be gleaned
as a matter of law from the four corners of the SPA.
To be sure, >Z[ZcYVciwh XdchigjXi^dc d[ MZXi^dch .-+.-&W' VcY .-+1&Y' as a
hZch^WaZ VaadXVi^dc id i]Z <jnZg d[ i]Z MZaaZgwh g^h` i]Vi i]Z =dbeVcnwh ZbeadnZZh
and managers were not honest brokers might ultimately prevail as the most
reasonable. But it is not the only reasonable construction allowed by these
provisions. As Plaintiff notes, a reasonable construction of Section 10.10(b) is that
it confirms, tTcUdil^i]hiVcY^c\ Vcni]^c\ ^c i]^h ;\gZZbZci to the contrary)u
62 Answering Br. 27 (citing Pontone v. Milso Indus. Corp., 100 A.3d 1023, 1049 (Del Ch. /-.1' &tTOUcYZg i]Z gjaZ d[ XdcigVXi ^ciZgegZiVi^dc + + + heZX^[^X egdk^h^dch h]djaY egZkV^a dkZg \ZcZgVa egdk^h^dch+u''+
63 See Schiepisi v. Roberts, 974 N.Y.S.2d 446, 447 (N.Y. App. Div. 2013) (holding that under Delaware aVl YjZa^c\ tcdil^i]hiVcY^c\u egdk^h^dch ^c V XdcigVXi XgZViZY VbW^\j^in and therefore denying summary judgment).
29
^cXajY^c\ tVcn a^b^iVi^dch dc gZbZY^Zh dg gZXdkZg^Zh)u i]Vi JaV^ci^[[wh tg^\]ih dg
VW^a^in id bV^ciV^c dg gZXdkZgu [dg tany action or claim based upon [gVjYu shall not
WZ ta^b^iZY dg gZhig^XiZY+u64 This very broad language, apparently deliberate in its
placement, does not delineate beilZZc tXdcigVXijVau VcY tZmigV-XdcigVXijVau [gVjY
claims, but rather reasonably can be read to reflect that the parties agreed that there
would be no limitations on recovery from the Sellers for any action or claim based
upon fraud.65
64 SPA § 10.10(b) (emphasis added). See Unified Indus., Inc., 929 F.Supp. at 950 &Xdchigj^c\ i]Z e]gVhZ tXaV^bh ^ckdak^c\ [gVjYu Vh tXdciZbeaVte[ing] a wider range of claims than those that actually allege a cause of action for [gVjYu'+
65 =GG +NNG[ X' ?'=' .GR]V QH 2GCNVJ $ 2WOCP =GTXU', 590 F.3d 1195, 1207 (11th Cir. 2009) &tN]Z VY_ZXi^kZ vVcnw ]Vh Vc ZmeVch^kZ bZVc^c\ VcY gZ[Zgh id vZkZgnw dg vVaaw d[ i]Z hjW_ZXi i]Vi ^i ^h YZhXg^W^c\+u'+ Delaware courts may look to dictionaries to aid in the search for plain meaning where contract terms are undefined. Northwestern Nat. Ins. Co. v. Esmark, Inc., 672 A.2d 41, 44 (Del. 1996). Merriam-QZWhiZgwh Collegiate Dictionary has defined tVcnu Vh tdcZ dg hdbZ ^cY^hXg^b^cViZan d[ l]ViZkZg `^cY)u tdcZ hZaZXiZY l^i]dji gZhig^Xi^dc)u tdcZ) hdbZ) dg Vaa ̂ cY^hXg^b^cViZan d[ l]ViZkZg fjVci^in)u VcY tjcbZVhjgZY dg jca^b^iZY ^c Vbdjci) cjbWZg) dg ZmiZci+u MERRIAM-WEBSTERwS COLLEGIATE
DICTIONARY 53 (10th ed. 1996). See also U.S. v. Unified Indus., Inc., 929 F.Supp. 947, 950r2. &?+>+ PV+ .663' &tN]Z bdgZ eaVjh^WaZ eaV^c bZVc^c\ d[ i]Z e]VhZ v^ckdak^c\ [gVjYw is that it contemplates a wider range of claims than those that actually allege a cause of VXi^dc [dg [gVjY+ BVY =dc\gZhh ̂ ciZcYZY id a^b^i i]Z TgZaZkVci hiVijiZwhU ZmXZei^dc id XVjhZh of action for fraud, the statute presumably would have so provided explicitly, by referring heZX^[^XVaan id XaV^bh vd[ [gVjYw dg v[dg [gVjY+w CchiZVY) =dc\gZhh X]dhZ id jhZ i]Z bdgZ \ZcZgVa e]gVhZ) vVcn XaV^b ^ckdak^c\ [gVjY+w N]Z jhZ d[ i]^h WgdVYZg aVc\jV\Z gZ[aZXih V congressional intent to except from [the statute] exclusivity not only causes of action for fraud in particular, but also actions the factual bases of which are intertwined with VaaZ\Vi^dch d[ [gVjY+u).
30
tDismissal, pursuant to Rule 12(b)(6) is egdeZg dcan ^[ i]Z YZ[ZcYVcihw
^ciZgegZiVi^dc ^h i]Z dcan gZVhdcVWaZ XdchigjXi^dc Vh V bViiZg d[ aVl+u66 ;h <jnZgwh
construction of Section 10.10 is reasonable, and may or may not prove to be most
reasonable, the Motion must be denied. tTCUcZaZ\Vci YgV[i^c\u ]Vh aZ[i i]Z =djgi
unable definitively to construe the indemnification provisions of the SPA in a
manner that would enable final adjudication of this dispute at the pleading stage.67
The Court will require extrinsic evidence to construe the ambiguous indemnification
provisions within Article X before determining which of the competing
^ciZgegZiVi^dch gZ[aZXih i]Z eVgi^Zhw ^ciZci l^i] gZheZXi id ^cYZbc^[^XVi^dc [dg XaV^bh
of fraud against the Seller arising from misrepresentations by the Company.68
66 See VLIW Tech., 840 A.2d at 615.
67 =VQEMOCP X' 2GCTVNCPF 3PFWU' ;]TU% 6;, 2009 WL 2096213, at *9 (Del. Ch. July 14, /--6' &cdi^c\ i]Vi t^cZaZ\Vci YgV[i^c\u ]ad given rise to a dispute regarding the meaning of indemnification provisions within a partnership agreement).
68 See Eagle Indus., Inc. v. DeVilbiss Health Care, Inc., 702 A.2d 1228, 1232 (Del. 1997) (stating that where a contract is susceptible to multiple reasonable interpretations there is ambiguity, which then requires the reviewing court to consider extrinsic evidence in order to construe those ambiguous contract provisions).
31
3. Plaintiff has Adequately Pled Fraud by the Company
Defendant contends that even if the SPA allows Plaintiff to seek
indemnification without any caps based on fraudulent misrepresentations by the
Company, Plaintiff has not pled fraud against the Company with the requisite
particularity. To state a claim for fraud, a plaintiff must
plead facts supporting a reasonable inference that: (1) the defendant falsely represented or omitted facts that the defendant had a duty to disclose; (2) the defendant knew or believed that the representation was false or made the representation with a reckless indifference to the truth; (3) the defendant intended to induce the plaintiff to act or refrain from acting; (4) the plaintiff acted in justifiable reliance on the representation; and (5) the plaintiff was injured by its reliance.69
Court of Chancery LjaZ 6&W' gZfj^gZh i]Vi tT^Uc Vaa VkZgbZcih d[ [gVjY dg b^hiV`Z)
the circumstances constituting fraud or mistake shall be stated with particularity.
Malice, intent, knowledge and other condition of mind of a person may be averred
\ZcZgVaan+u Against this heightened pleading standard, to state a claim for fraud, a
complaint must contain allegations of tthe time, place and contents of the false
representations, the facts misrepresented, as well as the identity of the person making
the representation and what he obtained thereby+u70 And while Rule 9(b) allows a
plaintiff to plead `cdlaZY\Z \ZcZgVaan) V eaV^ci^[[ tbjhi VaaZ\Z hj[[^X^Zci [VXih [gdb
69 Abry, 891 A.2d at 1050.
70 7GVTQ -QOOE]P -QTR'% ,@3% X' +FXCPEGF 7QDKlecomm Techs. Inc., 854 A.2d 121, 144 (Del. Ch. 2004) (citation omitted).
32
which it can reasonably be inferred that [whatever the defendant is alleged to have
known] was knowVWaZ VcY i]Vi i]Z YZ[ZcYVcih lZgZ ^c V edh^i^dc id `cdl ^i+u71
When a plaintiff alleges that fraudulent statements appear in a contract, the
pleading burden is easily satisfied for elements other than knowledge for the simple
reason that
The plaintiff can readily identify who made what representations where and when, because the specific representations appear in the contract. The plaintiff likewise can readily identify what the defendant gained, which was to induce the plaintiff to enter into the contract. Having pointed to the representations, the plaintiff need only allege facts sufficient to support a reasonable inference that the representations were knowingly false.72
>Z[ZcYVcih VhhZgi i]Vi JaV^ci^[[ ]Vh cdi VYZfjViZan eaZY i]Z =dbeVcnwh
knowledge of the fraudulent statements and that, in any event, Plaintiff has not
adequately pled that certain of the alleged misrepresentations were ever made. I
disagree.
a. >QFNSYNKK MFX /IJVZFYJQ^ >QJI YMJ 1TRUFS^_X 8ST\QJILJ
Defendants argue first that the Complaint does not adequately allege that the
Company acted with knowledge when it made the false representations in the SPA
gZ\VgY^c\ i]Z =dbeVcnwh QCJ bdYZa VcY i]Z VXXjgVXn d[ i]Z =dbeVcnwh [^cVcX^Va
statements tbecause Plaintiff has not tied any knowledge of wrongdoing to the
71 Abry, 891 A.2d at 1050.
72 Prairie Capital III, L.P. v. Double E Hldg. Corp., 132 A.3d 35, 62 (Del. Ch. 2015).
33
XdgedgViZ V\Zcih gZhedch^WaZ [dg bV`^c\ i]Z =dbeVcnwh gZegZhZciVi^dch+u73 They
argue that the Complaint only contains allegations of lower-level employees
engaging in fraudulent accounting practices and that unidentified senior-level
employees may have acted with knowledge of the wrongdoing.
To reiterate, Delaware law is that a plaintiff adequately pleads knowledge in
the context of fraud when he pleads facts that allow a reasonable inference that the
false gZegZhZciVi^dc lVh t`cdlVWaZ VcY [] the defendants were in a position to know
^i+u74 Nevertheless, Defendants urge this court to take guidance from federal
securities fraud cases and adopt a more searching pleading standard75 that would
impose a thig^c\Zci gjaZ [dg ^c[ZgZcXZh ^ckdak^c\ hX^ZciZg+u76 Delaware has not
73 Opening Br. of Defs. in Supp. of their Mot. to Dismiss the Verified =dbea+ &tIeZc^c\ <g+u' /0+
74 Abry, 891 A.2d at 1050 (holding that the Plaintiff had adequately pled knowledge where i]Z hZaaZgwh ZbeadnZZ ]VY Y^hXjhh^dch l^i] i]Z WjnZg VWdji i]Z iVg\Zi XdbeVcnwh ?<CN>; and was in close contact with management of the targei XdbeVcn VWdji i]Z iVg\Ziwh financials, placing him in a position to have knowledge of the falsity of the financial statements and with an obvious motive to engage in wrongdoing).
75 See Opening Br. 24r25. These federal securities fraud cases cited by the Defendants fall jcYZg i]Z Jg^kViZ MZXjg^i^Zh F^i^\Vi^dc LZ[dgb ;Xi &tJMFL;u') l]^X] gZfj^gZh XdbeaV^cih id thiViZ l^i] eVgi^XjaVg^in [VXih \^k^c\ g^hZ id V higdc\ ^c[ZgZcXZ i]Vi i]Z YZ[ZcYVci VXiZY l^i] i]Z gZfj^gZY hiViZ d[ b^cY+u .2 O+M+=+ p 45j-4(b)(2). In contrast, Delaware law and Court of Chancery Rule 9(b) only require that `cdlaZY\Z WZ tVkZggZY \ZcZgVaan+u
76 Teamsters Local 445 Freight Div. Pension Fund v. Dynex Capital Inc., 531 F.3d 190, 194 (2d Cir. 2008).
34
adopted this more stringent pleading standard for common law fraud,77 and I decline
to do so here.
Under Delaware law, principles of agency law supply ti]Z \ZcZgVa gjaZ i]Vi
knowledge of an officer or director of a corporation will be imputed to the
XdgedgVi^dc+u78 More specifically, courts will impute the knowledge of corporate
actors to its XdgedgViZ ZbeadnZg tl]Zc i]Z V\Zci lVh VXi^c\ l^i]^c i]Z hXdeZ d[ ]^h
Vji]dg^in+u79 Following this, for the Complaint adequately to plead that the
Company had knowledge of the fraud, Plaintiff must simply plead that the
=dbeVcnwh ZbeadnZZh ]VY `cdlaZY\Z df the fraud.80
77 See Snowstorm Acq. Corp. v. Tecumseh Prod. Co., 739 F.Supp. 2d 686, 708 (D. Del. /-.-' &tCc >ZaVlVgZ + + + V XaV^b [dg Xdbbdc aVl [gVjY ^h cdi hjW_ZXi id i]Z ]Z^\]iZcZY eaZVY^c\ hiVcYVgYh d[ i]Z JMFL; + + +u'+
78 Teachers Ret. Sys. of La. v. Aidinoff, 900 A.2d 654, 671 n.23 (Del. Ch. 2006). See also Albert v. Alex. Brown Mgmt. Servs., Inc., 2005 WL 2130607, at *11 (Del. Ch. Aug. 26, /--2' &t>ZaVlVgZ aVl hiViZh i]Z `cdlaZY\Z d[ Vc V\Zci VXfj^gZY l]^aZ VXi^c\ l^i]^c i]Z hXdeZ d[ ]^h dg ]Zg Vji]dg^in ^h ^bejiZY id i]Z eg^cX^eVa+u'+
79 Abry, 891 A.2d at 1050 n.35 (citation omitted).
80 See Affordable Home Enters., Inc. v. Nelson, 1994 WL 315227, at *3 (Del. Super. Ct. May 25, 1994) &t>ZaVlVgZ aVl hiViZh i]Z `cdlaZY\Z d[ Vc V\Zci VXfj^gZY l]^aZ VXi^c\ within the scope of his or her authority is imputable to the principal. Similarly, knowledge of an employee is imputed to the employer. This imputation occurs even if the agent does cdi Xdbbjc^XViZ i]^h ̀ cdlaZY\Z id i]Z eg^cX^eVa,ZbeadnZg+u'+ See also Aidinoff, 900 A.2d at 671 n.23; Alex. Brown, 2005 WL 2130607, at *11.
35
Plaintiff readily meets this standard. As illustrated in the following chart,
egdYjXZY ̂ c JaV^ci^[[wh ;chlZg^c\ <g^Z[) i]Z VaaZ\Vi^dch ̂ c i]Z =dbeaV^ci i]Vi gZkZVa
Company knowledge of the alleged fraudsactual and imputedsare extensive.
EMSI Employee Knowledge Allegations
Chief Financial Officer, who reported to Defendants Brook and Davis
' Told the Division Controller for the Healthcare business not to ask questions when she was told by the Executive Vice President of Healthcare Operations to make arbitrary and objectively incorrect changes to the =dbeVcnwh QCJ bdYZa WZXVjhZ i]Zn lZgZ tbVcV\ZbZci YZX^h^dchu i]Vi bjhi WZ [daadlZY+ (Compl. ¶¶ 113, 115).
' MXdaYZY ?GMCwh WVc`Zgh l]Zc i]Zn hX]ZYjaZY V discussion about WIP, the very financial statement line item the Company was manipulating during the sale process, explaining that WIP should only be discussed ^c V thbVaaZg \gdje+u &Id. ¶ 162).
Controller ' Explicitly directed the operations team to remove thiVaZu egd_ZXih [gdb QCJ gZkZcjZ dc DjcZ 1, 2015 WZXVjhZ ]Z lVh tXdcXZgcZY VWdji i]Z [jijgZu ^[ i]Zn were not removed. (Id. ¶ 75).
' <ji i]Zc V\gZZY id Vaadl i]dhZ thiVaZ egd_ZXih)u representing millions of dollars of revenue, to remain ^c i]Z =dbeVcnwh [^cVcX^Va hiViZbZcih [dg i]Z cZmi [^kZ months, including in the October 2015 Interim Financial Statements. (Id. ¶¶ 76, 160).
Executive Vice President of Healthcare Operations
' FZVgcZY i]Z =dbeVcnwh ;j\jhisOctober 2015 WIP models included duplicate entries, representing nearly $500,000 of revenue and earnings, for the exact same project, yet decided to leave the duplicate entries in the =dbeVcnwh IXidWZg /-.2 CciZg^b @^cVcX^Va Statements. (Id. ¶¶ 140r142).
' Intentionally left stale revenue in the WIP model despite prior instructions from lower-level employees that it should be written off. (Id. ¶¶ 73r76).
36
EMSI Employee Knowledge Allegations
Division Controller of Healthcare Operations
' >^gZXiZY Wn ?GMCwh hZc^dg bVcV\ZbZci) ̂ cXajY^c\ i]Z Executive Vice President of Healthcare Operations, to bVc^ejaViZ ?GMCwh [^cVcX^Va gZXdgYh Wn YZaZting the WIP Milestone formulas and replacing those formulas with numbers that produced substantially higher revenue and earnings than would have been produced by the normal operation of the WIP formulas. (Id. ¶¶ 84r90).
' Met with the Executive Vice President of Healthcare Operations on the morning of September 5, 2015 and consciously and intentionally made arbitrary changes id i]Z =dbeVcnwh QCJ bdYZa &l^i]dji Vcn Wjh^cZhh justification) to increase the amount of revenue and earnings EMSI could report in the October 2015 Interim Financial statements. (Id. ¶ 112).
Chief Sales Officer ' Solicited a file from a customer after he was told to thlZVg ^c WaddYu id i]Vi XjhidbZg i]Vi i]Z =dbeVcn would not work on itsand then proceeded to recognize revenue on the project. (Id. ¶ 117)
Defendant Brook (former Executive Vice President and JgZh^YZci d[ ?GMCwh Healthcare Services division)
' Developed the WIP Model, and thus was in the best position to know how it could be, and was being, manipulated by the Company. (Compl. ¶ 52).
' On several occasions, requested (or directed others to request) unapproved, preliminary files from clients on projects that the Company then included in revenue even though Defendant Brook knew the Company was not actually working on the project. (Id. ¶¶ 106r107, 116, 117).
' Emailed with the Executive Vice President of Healthcare Operations about creating two sets of books, one for internal and one for external (i.e., for Buyer) projections. (Id. ¶ 134).
Defendant Davis (former Chairman, President, and CEO of EMSI and signatory of the
' ;\gZZY cdi id tVh` bVcn fjZhi^dchu ^[ <gdd` XdjaY develop a plan to make up a $1 million budget shortfall less than a month into the sale process. (Id. ¶ 34).
' After seeing disappointing mid-month numbers for MZeiZbWZg /-.2) idaY ?GMCwh =]^Z[ IeZgVi^c\ I[[^XZg7
37
EMSI Employee Knowledge Allegations
=dbeVcnwh representations in the SPA)
tQZ cZZY i]Z \e T\gdhh egd[^iU egZhZciZY Tid <jnZgU aVhi c^\]i+u &Id. at ¶¶ 38, 137). The COO responded: tC `cdl) i]Viwh l]n Cwb ^c V W^i d[ V eVc^X+ Cwaa [^\jgZ hdbZi]^c\ dji+u &Id.) Immediately after that, the Company turned to manipulating the WIP model, including by double booking revenue and income from the exact same project and loading projects into the =dbeVcnwh QCJ bdYZa Vi kdajbZh i]Vi lZgZ cdi _jhi incorrect, but dramatically higher than the volume in ?GMCwh XdciZbedgVcZdjh Wjh^cZhh gZXdgYh Vi i]Z i^bZ+ (Id. ¶¶ 139r144).
' After extensive manipulations of the WIP model in the prior months, told Defendant Rob Brook how to spin i]Z =dbeVcnwh \gdl^c\ QCJ WVlance to Buyer, by XaV^b^c\ i]Vi i]Z th]dgi[Vaah l^aa WZ bVYZ je+u &Id. at ¶ 156r157).
' Tightly controlled due diligence, prohibiting any employee from discussing WIP. (Id. ¶¶ 161r62)
These allegations meet Delaware standards for pleading knowledge as a basis
for fraud in that they allow a reasonable inference the alleged fraud was knowable
VcY i]Vi hZc^dg bZbWZgh d[ i]Z =dbeVcnwh bVcV\ZbZci ^ckdakZY ^c i]Z hVaZh
process, including Defendants Brook and Davis, were in a position to know it.81
81 See Aviation W. Charters, LLC v. Freer, 2015 WL 5138285, at *7 (Del. Super. Ct. July 2, 2015) (holding that, in a case alleging fraudulent accounting practices in connection with an acquisition, the complaint satisfied the knowledge requirement under Rule 9(b) for the claim that the buyers were fraudulently induced to enter into the acquisition because the XdbeaV^ci gZVhdcVWan ^c[ZggZY i]Vi tvhdbZi]^c\w lVh `cdlVWaZ VcY i]Vi i]Z YZ[ZcYVciThU [were] in a position to know itu by alleging that the defendants knew that some of the financials were inflated, that the defendants, by manipulating the financial statements, knowingly concealed the true financial condition of the company and that they also knew of the falsity of the EBITDA reprehZciVi^dch YjZ id i]Z XdbeVcnwh gZkZcjZ gZXd\c^i^dc practices) (quoting 7GVTQ -QOOWPE]P, 854 A.2d at 147).
38
b. Plaintiff has Adequately Pled the Misrepresentations
Defendant also argues that Plaintiff has failed adequately to plead the falsity
of the representations listed in Complaint at paragraphs 192 (iii), (v), (vi), and (vii).82
First, Defendants argue that the Complaint does not adequately allege that the
t=dbeVcn [VahZan gZegZhZciZY i]Vi ̂ i ]VY cdi vZciZgZY ̂ cid Vcn V\gZZbZcihw id X]Vc\Z
i]Z =dbeVcnwh Wjh^cZhh egVXi^XZh dg VXXdjci^c\ bZi]dYh WZilZZc GVgX] 0.) /-.2
VcY =adh^c\+u83 In this regard, Defendants contend that the Complaint does not
allege that the Company had entered into any formal agreement to change business
practices or accounting methods. While this might be true, the Company represented
i]Vi ^i ]VY cdi tZciZgZY ^cid any V\gZZbZcihu id X]Vc\Z ^ih Wjh^cZhh practices and
accounting methods and the Complaint pleads facts that support a reasonable
inference that the Companywh ZbeadnZZh entered into an agreement, albeit not a
t[dgbVa V\gZZbZci)u id bdY^[n i]Z =dbeVcnwh Wjh^cZhh VcY VXXdjci^c\ egVXi^XZh
with regard to its WIP model by alleging that managers, in concert, engaged in
systematic manipulations of that model to misstate Company revenue.84
82 Defendants appear to have conceded that Plaintiff has adequately pled the misrepresentations set forth in paragraphs 192 (i), (ii), (iv), and (viii) of the Complaint. As stated earlier, the alleged misrepresentations in the SPA identified in the Complaint were made by the Company, not the Sellers.
83 Opening Br. 31 (quoting Compl. ¶ 192(v)).
84 See generally Compl. ¶¶ 69r160 (describing the process through which EMSI systematically manipulated the WIP Model from May to October 2015). See also Compl. ¶¶ 71r43 &tCc Vc ViiZbei id cVggdl ^ih b^hh id WjY\Zi T^c GVn /-.2U) ?GMC ijgcZY id i]Z
39
Next, Defendants argue that the Complaint fails to plead facts to support an
inference that the Company fraudulently misrepresented that it had not accelerated
WIP Model. Specifically, . . . EMSI decided to not write-off over $1 million of WIP revenue on projects it identified as completed in May 2015. . . . Remarkably, EMSI rejected Gh+ <gdd`wh X]Vc\Zh Tl]ZgZ h]Z ]VY lg^iiZc d[[ XZgiV^c egd_ZXih [gdb i]Z QCJU+ Ci reinserted the Stale Projects and the corresponding over $1 million of WIP revenue back ^cid i]Z GVn QCJ GdYZa+ + + + >Zhe^iZ i]Z =dcigdaaZgwh XdcXZgch Ti]Vi XZgiV^c egd_ZXih should not be in the WIP], the Stale Projects Ms. Brook identified remained in the WIP GdYZa [dg GVn /-.2) Vgi^[^X^Vaan ^cXgZVh^c\ ?GMCwh revenue and EBITDA for the month Wn lZaa dkZg $. b^aa^dc+u'8 ¶¶ 80r5/ &tDjcZ /-.2 hiVgiZY ZkZc ldghZ i]Vc GVn /-.2+ Q]Zc EMSI issued its Mid-Month revenue estimate on June 16, 2015, it estimated a $1.6 million miss to its forecast, including a $1.7 million miss in the Healthcare business. Davis asked <gdd`7 vCh i]ZgZ Vcni]^c\ i]Vi XVc ijgc i]^h id V bdgZ edh^i^kZ djiXdbZ [dg DjcZ9w Cc response, EMSI again turned to manipulating the WIP Model to close the Mid-Month gap. EMSI began to panic . . . when its client did not send the final [approval for a large project] by late June. Instead of simply waiting to recognize revenue until it actually received the [^cVa) VeegdkZY N=F i]Z [daadl^c\ bdci]) ?GMCwh deZgVi^dch iZVb Y^gZXiZY V bZbWZg d[ ?GMCwh CN YZeVgibZci id XgZViZ V v[V`Zw a^hi d[ bZY^XVa gZXdgYh + + + hd i]Vi ̂ i XdjaY adVY i]Z project into its IT systems and bZ\^c gZXd\c^o^c\ QCJ gZkZcjZ+u'8 ¶¶ 84r53 &tTCUc DjcZ 2015, EMSI manually overrode the WIP Milestone formulas in the WIP Model by manually advancing a number of projects to a later Milestone in order to recognize a greater percentage of WIP revenue. . . . The Division Controller was directed to manually override the WIP Milestone formulas by her superiors after she had repeatedly voiced her doubts about the propriety of it. The Division Controller was told repeatedly that the decision to dkZgg^YZ i]Z QCJ G^aZhidcZ [dgbjaVh lVh V vbVcV\ZbZci YZX^h^dc+wu'8 ¶ 62 &tNd a^b^i i]Z budget shortfall in July 2015, EMSI again turned to manipulating the WIP GdYZa+u'8¶¶ 109r..- &t;j\jhi /-.2 [daadlZY i]Z hVbZ eViiZgc Vh GVn) DjcZ) VcY Djan+ + + + Nd narrow the budget shortfall in August 2015, EMSI again turned up the volume of its [^cVcX^Va bVc^ejaVi^dc+u'; ¶¶ 136r.05 &tQ]Zc ?GMC ^hhjZY ^ih G^Y-Month estimated revenue on September 17, 2015, it estimated that it was $1.6 million behind its revenue WjY\Zi [dg i]Z bdci]) ̂ cXajY^c\ Vc $5--)--- b^hh ̂ c BZVai]XVgZ+ + + + ?GMC Y^Y cdi v[^\jgZ hdbZi]^c\ dji)w Vi aZVhi cdi ^c i]Z hZchZ d[ deZgVi^dcVa ^begdkZbZcih) ^n September. Instead, it turned back to its now-familiar playbook o[ bVc^ejaVi^c\ i]Z QCJ GdYZa+u'8¶ .16 &tTCc IXidWZg) l^i]U i]Z YZVa ZmeZXiZY id XadhZ Vi i]Z ZcY d[ i]Z bdci]) ?GMC understood that it needed to keep the house of card standing for at least one more month. Thus, after releasing the Mid-Month projecting another down month, EMSI again turned to its familiar pattern of manipulation in October in hopes of closing the gap to the WjY\Zi+u'+
40
the collection of any accounts receivable, as alleged in Complaint Paragraph 192(iii),
but rather only alleges that the Company accelerated recognition of revenue. The
Complaint says otherwise.85
Defendants then argue that the Complaint does not adequately allege that the
=dbeVcn WgZVX]ZY ^ih tbViZg^Va VYkZghZ Z[[ZXiu gZegZhZciVi^dc i]gdj\] ^ih
dkZghiViZbZci d[ ?<CN>; Wn $1+3 b^aa^dc+ Q]^aZ C VX`cdlaZY\Z i]Vi i]Z tbViZg^Va
VYkZghZ Z[[ZXiu hiVcYVgY is high,86 this court will find that a plaintiff has adequately
pled a material adverse effect if the pled facts support a reasonable inference that the
b^hgZegZhZciVi^dch tXdjaY egdYjXZ XdchZfjZcXZh i]Vi VgZ bViZg^Vaan VYkZghZ id i]Z
=dbeVcn+u87 In the Complaint, Plaintiff alleges that the adverse consequences to
the Company of the fraudulent practices are i]Vi ti]Z =dbeVcn ]Vh WZZc [dgXZY id
let go numerous employees, fire the auditors, scrap the WIP model, and deal with
much tighter cash flow than anticipated, constraining its ability to grow the business
VcY Xdbean l^i] ^ih YZWi XdkZcVcih+u88 Whether this will be borne out in discovery
85 See Compl. ¶¶ 106, 111, 123, 133 (all alleging alleged intentional manipulation of accounts receivable).
86 See Hexion Specialty Chems., Inc. v. Huntsman Corp., 965 A.2d 715, 738 (Del. Ch. /--5' &t>ZaVlVgZ Xdjgih ]VkZ cZkZg [djcY V bViZg^Va VYkZghZ Z[[ZXi id ]VkZ dXXjggZY ^c the context of a merger agreZbZci+u'+
87 Osram Sylvania Inc. v. Townsend Ventures, LLC, 2013 WL 6199554, at *7r9 (Del. Ch. Nov. 19, 2013).
88 Answering Br. 50 (citing Compl. ¶¶ 176r77).
41
remains to be seen, but the Complaint supports a pleading-stage inference that the
Company intentionally misled the Buyer with respect to its material adverse effect
representation.89
Lastly, Defendant argues that the Complaint does not contain allegations that
the Company committed fraud with regard to ^ih gZegZhZciVi^dc i]Vi tvtrue and
XdbeaZiZw Xde^Zh d[ ^ih ^ciZg^b financial statements for the period ended
September 0-) /-.2 lZgZ ViiVX]ZY id i]Z MJ;+u90 Not so. The theme that runs
throughout the Complaint is that the Company misrepresented its financial fitness
both in its financial statements and otherwise. Moreover, the Complaint alleges
specifically that the interim financial statements reported $10.4 million in EBITDA
for the twelve-bdci] eZg^dY ZcY^c\ MZeiZbWZg 0-) /-.2) Wji t$1+3 b^aa^dc d[ i]Vi
?<CN>; lVh [V`Z) Viig^WjiZY dcan id ?GMCwh [^cVcX^Va bVc^ejaVi^dcs in the year
eg^dg id Xadh^c\+u91 This is adequate to support a reasonable inference that the copies
89 See Osram, 2013 WL 6199554, at *7r9 (holding that the Complaint stated a pleading-stage inference that the material adverse effect representation in the relevant purchase agreement had been breached where the acquired XdbeVcn t]VY bVYZ dcan ]Va[ d[ ^ih forecasted sales in Third Quarter 2011, and therefore had achieved $2 million less in revenues, reasonably could be interpreted as reflecting a change in circumstances that was vbViZg^Vaan VYkZghZ id i]Z <jh^cZhh) + + + gZhjaihT) VcYU deZgVtions of the Acquired Companieswu'+
90 Opening Br. 31.
91 Compl. ¶ 178.
42
of the Interim Financial Statements supplied to the Buyer were not i]Z =dbeVcnwh
tigjZ VcY completeu financial statements.
*************
Having found that Plaintiff has adequately eaZY i]Z =dbeVcnwh `cdlaZY\Z
and the fraudulent misrepresentations in the SPA, the rest of the elements of the
claim for fraud are easily satisfied.92 It is reasonably conceivable that the Defendants
intended that Plaintiff would rely on the misrepresentations since they were included
in the SPA. Plaintiff has alleged causally related harm because it would not have
purchased, or would have paid materially less to purchase, EMSI but for these
allegedly fraudulent misrepresentations.93
C. >QFNSYNKK MFX 4FNQJI YT >QJFI F 1QFNR KTW 1TSKNWRFYNTS TK YMJ /ZINYTW_X Award
In the second count of the Complaint, Plaintiff seeks confirmation of the
findings of the Settlement Auditor pursuant to 10 Del. C. §§ 5701 and 5713, and the
entry of judgment for the amount of the award that has not been satisfied through
the Escrow Funds. Defendants riposte that i]Z MZiiaZbZci ;jY^idgwh YZX^h^dc ^h cdi
an arbitration award that can be confirmed by this court as that would contradict the
explicitly bargained-for language found in the SPA. I agree.
92 See Prairie Capital, 132 A.3d at 62.
93 Compl. ¶¶ 164r73.
43
As noted, i]Z eVgi^Zhw gZaVi^dch]^e ^h \dkZgcZY Wn i]Z iZgbh d[ i]Z MJ;)
pursuant to which the Settlement Auditor undertook its work on behalf of the parties.
The SPA provided that the Settlement Auditor would resolve any disputes regarding
the calculation of net working capital at closing, which would then affect the ultimate
purchase price. The Settlement Auditor did its work and found that financial
statements delivered to Plaintiff at the closing of the transaction were not in
compliance with GAAP and that adjustments totaling $9.8 million were required.
While Delaware law favors private arbitration of disputes,94 that does not
negate the requirement that V tXdcigVXi bjhi gZ[aZXi i]Vi i]Z eVgi^Zh XaZVgan VcY
^ciZci^dcVaan WVg\V^cZY [dg l]Zi]Zg VcY ]dl id VgW^igViZ+u95 Therefore, parties
tXVccdi WZ [dgXZY id VgW^igViZ i]Z bZg^ih d[ V Y^hejiZ + + + ^c i]Z VWhZcXZ d[ V XaZVg
expression of such intent in a valiY V\gZZbZci+u96 Here, the SPA explicitly provides
that the Settlement Auditor will resolve disputes over the calculation Net Working
=Ve^iVa tVXi^c\ Vh Vc ZmeZgi VcY cdi Vc VgW^igVidg+u97 If I were to interpret the
MZiiaZbZci ;jY^idgwh YZX^h^dc Vh an arbitration award, I would violate two of the
cardinal principles of contract construction: terms within a contract must be afforded
94 DMS Props.-First, Inc. v. P.W. Scott Assocs., Inc., 748 A.2d 389, 391 (Del. 2000).
95 Kuhn Const., Inc. v. Diamond State Port Corp., 990 A.2d 393, 396 (Del. 2010).
96 DMS Props.-First, 748 A.2d at 391.
97 SPA § 2.3(b).
44
their plain meaning and any such plain terms should not be read to render other
provisions meaningless.98 While Plaintiff is correct that in certain instances an
tZmeZgiwhu YZX^h^dc ^c V Y^hejiZ gZhdaji^dc egdXZZY^c\,99 or the eVgi^Zhw course of
conduct during a dispute resolution proceeding,100 may be tantamount to an
arbitration, that cannot be the case where the contract language on point expressly
states that the auditor/expert is not acting as an arbitrator. Therefore, in keeping with
i]Z eaV^c bZVc^c\ d[ i]Z MJ;) i]Z MZiiaZbZci ;jY^idgwh YZiZgb^cVi^dc XaZVgan ^h cdi
an arbitration award that can be confirmed under 10 Del. C. §§ 5701 and 5713.
Count II of the Complaint must be dismissed.101
98 See BLGH Hldgs. LLC v. enXco LFG Hldg., LLC) 1. ;+0Y 1.-) 1.1 &>Za+ /-./' &tQ]ZgZ . . . the plain language of a contract is unambiguous i.e., fairly or reasonably susceptible to only one interpretation, we construe the contract in accordance with that plain meaning and will not gZhedgi id Zmig^ch^X Zk^YZcXZ id YZiZgb^cZ i]Z eVgi^Zhw ^ciZci^dch+u'; Osborn, 991 ;+0Y Vi ..26 &tQZ l^aa gZVY V XdcigVXi Vh V l]daZ VcY lZ l^aa \^kZ ZVX] egdk^h^dc VcY term effect, so as not to render any part of the contract mere surplusage. We will not read V XdcigVXi id gZcYZg V egdk^h^dc dg iZgb bZVc^c\aZhh dg ̂ aajhdgn+u' &^ciZgcVa fjdiVi^dc bVg`h and citations omitted).
99 See SRG Global, Inc. v. Robert Family Hldgs., Inc., 2010 WL 4880654, at *5 (Del. Ch. Nov. 30, 2010).
100 See Mehiel v. Solo Cup Co., 2007 WL 901637, at *3 (Del. Super. Ct. Mar. 26, 2007).
101 This determination should not be construed as an opinion regarding binding effect of i]Z MZiiaZbZci ;jY^idgwh YZX^h^dc dg l]Zi]Zg i]Z XVe dc eVnbZci [gdb i]Z ?hXgdl @jcYh applies to the Settlement ;jY^idgwh YZX^h^dc+ Those questions were not called by the Motion.
45
III. CONCLUSION
@dg i]Z [dgZ\d^c\ gZVhdch) >Z[ZcYVcihw bdi^dc id Y^hb^hh i]Z PZg^[^ZY
Complaint is DENIED as to Count I and GRANTED as to Count II.
IT IS SO ORDERED.